Why quality is king during economic downturns

A new report from VanEck has discussed how investors should be positioning their portfolio with consideration to the Iran-US conflict.

According to the report, US consumer sentiment has plunged to a record low. At the same time, inflation expectations have spiked, and global growth forecasts are being revised down.

Despite this, equity markets continue to rally. 

Furthermore, the S&P 500 has climbed to reach an all-time high, despite oil prices remaining elevated above US$90/barrel (at the time of writing), the Strait of Hormuz remaining disrupted, and a US naval blockade on Iranian ports now in effect.

VanEck believes the market is underestimating the risks of a slowdown.

The ASX ETF provider has pointed to quality investing as a relevant strategy for investors to consider right now. 

What is quality investing?

Quality investing focuses on companies with strong financial health, characterised by high return on equity, manageable leverage levels, and consistent earnings stability over time to compound value and reduce risk.

According to VanEck, Quality companies have historically demonstrated outperformance during periods of economic slowdown and over the long term.

On the flip side, quality investments typically underperform when low interest rates and accommodative economic policy are dominant macroeconomic features. 

The case for quality right now

According to VanEck, history suggests that quality companies outperform during economic slowdowns, experiencing smaller declines during market downturns, and recovering more swiftly to previous levels. 

In our view, looking ahead, should risk sentiment roll back, or if the war continues for longer than expected it could spark economic growth concerns, increasing market volatility, and a ‘flight to quality’ could be triggered.”

Valuations-wise, while quality companies typically trade at a premium to the broader market due to their defensive characteristics, the valuation differential has narrowed toward the 10-year average. This makes for a potentially compelling entry point for quality companies, we think.

How to target quality 

There are several ASX ETFs available to investors that focus on these core quality principles. 

The first option to consider is the VanEck Vectors Msci World Ex Australia Quality ETF (ASX: QUAL). 

It provides investors with an international equity portfolio of 300 companies with fundamentals that satisfy principles of quality investing advocated by investment greats Benjamin Graham and Warren Buffett, namely:

• High ROE;
• Stable year-on-year earnings growth; and
• Low financial leverage.

Another option to consider is VanEck Msci International Quality (Hedged) ETF (ASX: QHAL). 

QHAL is an Australian dollar hedged version of QUAL so you can now also manage your desired currency exposure.

Another option for investors targeting quality investing is the Betashares Capital Ltd – Global Quality Leaders Etf (ASX: QLTY). 

It includes 150 of the highest quality global companies.

The post Why quality is king during economic downturns appeared first on The Motley Fool Australia.

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Motley Fool contributor Aaron Bell has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.